NEW YORK: There is a simple reason why US Treasury Secretary Henry Paulson’s $700bn bail-out package has been so hard to sell to politicians and the American people: it won’t really work. Despite the historically massive expenditure and all the little clauses to make sure Wall Street fat cats get their comeuppance, the plan is unlikely to do anything to save the world’s biggest economy from a long and crippling downturn.

It will doubtless save some banks from collapse, but is that worth the government putting itself on the hook for nearly a trillion dollars more than $3,000 for every man, woman and child in America? And that’s not the half of it. Not bailing out Wall Street with as much money as it would take to launch an American National Health Service presents an even bleaker prospect: a financial nuclear winter that could last a generation. In short, America is doomed if it does and even more doomed if it doesn’t get Paulson’s billions, perhaps the ugliest economic choice it has ever faced.

You can always rely on ‘Neutron Jack’ Welch, the former GE boss and all-round tough talker, to tell it how it is. “I now believe we are in for one hell of a deep downturn,” he told the World Business Forum in New York last Wednesday (Sept 24), adding that the first quarter of 2009 will be ‘brutal’.

Until recently, Welch said, he had believed the American economy could avoid recession, but he has changed his mind, despite the bail-out. “I am now caving,” he said. “Get ready for real tough times. They’re coming.”

Welch is not alone in his gloomy outlook. A day after the New York meeting, Peer Steinbruck, the German finance minister, predicted America will soon be knocked off its perch as the world’s leading economic superpower.

If you peel away this hyperbole, however, and consider the ramifications of such large-scale government intervention into the market as Paulson’s bail-out represents, even Steinbruck’s seemingly gratuitous slight sounds plausible.

The first question anyone thinking about the bail-out should surely ask is whether $700bn is enough, or indeed too much, to fix things. And where did that figure come from? David Wyss, chief economist at Standard & Poor’s, the New York credit rating agency, suggests that all the ‘level 3’ assets of all the biggest financial firms on Wall Street adds up to about $630bn. But this valuation is arbitrary at best, seeing as these sub-prime or toxic securities are only really worth what the market or in this case the US Treasury Department is willing to pay for them.

“I think the biggest risk to the financial system is if it turns out to be not enough,” says Barry Bosworth, a former economic adviser to President Carter and a senior economist at The Brookings Institution, a left-leaning Washington think-tank.

It is impossible to know how much money will be needed to mop up all of America’s sub-prime-related securitised debt because we don’t yet know how the Treasury intends to go about buying it. “There is so little agreement on this point on whether it should be a traditional auction or a reverse auction or some other process that the whole structure could very well fracture,” Bosworth says. “There is not enough detail.”

And the seemingly flawed mechanics of the bail-out are just the tip of the iceberg. Assuming the plan actually gets off the ground and the Treasury is able to organise some kind of workable asset sale, what will happen to the US economy once the banks have been ‘saved’? Will house prices automatically start to stabilise? Will jobs be created as if by magic? Will Americans suddenly find they have disposable income on hand to get their consumer-weighted economy whirring away again? Of course not.

And that is the plan’s biggest flaw. “My biggest fear is that all of this money, and it really is a very large amount, is going to be spent and none of it will be used to stimulate the economy,” Bosworth says.

In fact it is entirely possible that the economy will become even more paralysed after the bail-out than it is today, because the government will put such a strain on the already-creaking public finances that it will not be in a position to provide any sort of stimulus for a long time to come. America will be unable to spend its way out of this crisis.

Most critics of Paulson’s plan express concern over US taxpayers shelling out billions of dollars to bail out greedy Wall Street bankers, but this is a misconception. Taxpayers, who have been shocked by the scale of earnings of all-too-fallible ‘masters of the universe’ such as Lehman Brothers’ Dick Fuld and Bear Stearns’ Jimmy Cayne (see panel) are not directly paying for this; nor will they ever, because America does not have $700bn of taxpayers’ money. The government is in debt to the tune of $9.8 trillion. The entire sum will probably be borrowed from foreign governments and other purchasers of US Treasury bonds which creates further problems.

“Borrowing every penny of this $700bn could have very serious consequences,” Bosworth says. “Firstly, investors from other countries are going to see this as the biggest example yet of America’s lack of financial discipline. They may then very well decide they should not invest so heavily here and diversify their portfolios to invest less in US Treasuries, dollars and US equities and more in European bonds and the euro.”

This, of course, will drive the already weakened dollar down even further, which will not only suck more lifeblood out of the American economy but drive up the dollar-denominated price of oil and other commodities, adding inflationary pressure into the bargain. Talk about kicking a country while it is down.

Vincent Reinhart is a senior economist at the American Enterprise Institute, a conservative think-tank normally the antithesis of Brookings and its liberal scholars. He is in a particularly good position to criticise Paulson and Fed chairman Ben Bernanke’s latest work because he worked for the Federal Reserve for more than 25 years, much of it as a director on the monetary affairs board.

On the subject of the bail-out, however, he agrees almost entirely with Bosworth. In fact he goes even further, suggesting that what has been dubbed ‘Tarp’ (the Troubled Asset Relief Programme) will all but cripple whoever wins the presidential election in November.

“Who would want to be president and inherit this mess?” Reinhart asks, adding that most of the big decisions in the victor’s entire four-year term will be made by the Bush administration before inauguration day in January. “The whole four years will likely be bogged down in very dull financial regulation and legislation relating to this bill.”

What is more, with such immense pressure on public finances from the size of the debt incurred to fund it, Barack Obama can forget about spending increases and John McCain won’t have any room for tax cuts. So whoever wins will be unable to fulfil many of their manifesto pledges.

The next president will also face the prospect of a global depression to manage, and with it the possibility of strained relations with foreign governments.

China, so dependent on the US as top buyer of its manufactured goods, faces an abrupt slowdown as Americans tighten their belts. This of course will mean that China and other nations will be less able to purchase huge wads of US Treasuries even if they wanted to, further restricting America’s access to funds. “It certainly will change our relationship with our trading partners,” Reinhart says.

It is almost as if Paulson and Bernanke have created a plan that will see them through the next few months without concern for the long-term effects of their actions. “I regard this as nothing more than a stopgap measure to get us through the election,” says S&P’s Wyss.—Dawn/ The Guardian News Service